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Conn’s (CONN) Has Been Deemed a Perfect Short

The shares of Conn’s, Inc. (CONN) , are a “Perfect Short”. With the reporting of its most recent disappointing quarter and the resulting 50% decline of its share price and market cap during the week of December 8th, Conn’s meets all of the requirements as outlined in my Perfect Short Research™ criterion.

Conn’s was founded in 1890 and has approximately 80 retail stores that are primarily located in Texas, Arizona, Louisiana, Oklahoma, and New Mexico. The company sells durable consumer goods including furniture, appliances, electronics and mattresses on credit. Conn’s primary customers are minorities and consumers who have no credit or low credit scores.

The significant declines for Conn’s share price and market capitalization after reporting each of its quarterly results since the beginning of 2014, has been caused its growing volume of consumer credit delinquencies. The severe downdraft in its market cap and share price have severely restricted Conn’s ability to raise equity capital to reduce its burgeoning liabilities which are being caused by its chronic negative Cash Flow from Operations. Total liabilities increased by approximately 50% from $616 million to $919 million for 10/31/14 as compared to 10/31/13. Negative Cash Flow for Conn’s quarter and nine months ending 10/31/14 was $79 million $127 million respectively.

Since the start of 2014 Conn’s market capitalization has declined by 80% from $2.8 billion to $566 million. The company’s share price has gone from $79.02 on the first day of 2014 to a 52 week low of $15.30.

The key requirement that a company must meet before I can consider it a Perfect Short is that the company have multiple diagnoses of the “The EPS Syndrome” by StockDiagnostics.com. The syndrome is an algorithm that I developed that monitors for companies that are reporting cashless or phantom earnings. The StockDiagnostics.com website that I founded automatically diagnoses the syndrome and it also monitors the Cash Flow from Operations for all publicly traded companies. Conn’s was diagnosed as having the EPS syndrome for the last three consecutive quarters of its 2014 fiscal year.

Conn’s has missed its guidance and has had its share price gap down for each of its last three announced earnings reports. The down share price gaps for Conn’s have been severe and swift. See table and year to date share price chart below.

CONN’s Share Price Declines after Earnings Announcements

Report Date

Previous Close

Report Date Close

Decline

Decline %

02/20/2014

$55.80

$31.89

$23.91

43%

09/02/2014

$44.83

$31.00

$13.83

31%

12/09/2014

$35.09

$20.83

$14.26

41%

I am predicting that Conn’s will seek bankruptcy protection before it concludes its current fiscal year ending January 31, 2015, at the earliest; or before it reports its fiscal year end results in April of 2015, at the latest. My prediction is based on the following:

Conn’s has been reporting cashless earnings or phantom earnings to manipulate or keep its share price propped up. Prior to its 3rd quarter of 2015, Conn’s had reported positive EPS for its last 10 consecutive quarters. The company has generated negative cash flow from operations for 9 of its last 10 reported quarters.

Based on a flurry of announcements by law firms during the three day period after the company made its December 9, 2014, earnings announcement the company will soon be subjected to a bevy of class action lawsuits. The probability is high that Conn’s could soon face an SEC investigation.

Conn’s announced the departure of its CFO on December 8th. The interim replacement has no experience as a CFO. He joined the company as its Vice President and Chief Accounting Officer in October of 2014 and held the same title for Coldwater Creek which filed for bankruptcy earlier in 2014. The company will not be able to hire a credible CFO.

Conn’s can no longer keep its credit dependent revenue model going since its most recent quarter was its first losing quarter after a string of 10 consecutive positive EPS quarters. Its inability to further perpetrate its cashless earnings is the reason why the CFO resigned. It’s also why it will be impossible for the company to get its auditor, Ernst & Youngto sign off on its Financial Statements for its fiscal year ending January 31, 2015. It’s for this reason that I predict the audit that Conn’s obtained for its fiscal year ended January 31, 2014 will be its last.

When Conn’s Board of Directors comes to the reality that it cannot hire a credible CFO or get its auditors to opine on its financials they will put the company into bankruptcy. This is especially true since Conn’s has highly credible sophisticated individuals on its Board of Directors. They include the former CEO of Dollar Thrifty which was sold to Hertz and three individuals who are associated with Stevens Inc., a prominent investment firm out of Little Rock Arkansas.

The price of oil declined from $80 when Conn’s fiscal third quarter ended on 10/31/14 to a recent low of $57. This is very bad news for the company since half of its retail stores are located in Texas.

Based on what was stated in their recent press release Conn’s Board of Directors appears to be dazed and confused. They are grasping for straws based on this excerpt from the press release:

“The Board of Directors is taking these actions in response to the growing scale and complexity of the Company’s credit business, along with increasing industry-wide regulatory scrutiny.”

Conn’s management and Board of Directors are in an extremely risky position. With exception of Lehman Brothers, a principal officer of every company that I have discovered that qualified to be deemed as a Perfect short in the past has been convicted and has served time for the accounting frauds that were perpetrated by their respective companies. This includes the principals of the two companies, AstroPower and Suprema Specialties, known as the poster children for practicing manipulative accounting. More information on this can be found on the www.onlinefinancialsector.com website and in the informational video about The EPS Syndrome. The principals of two other companies, including cable TV company, Adelphi Communications and MCSI, which were diagnosed with the EPS Syndrome and also qualified as Perfect Shorts were convicted and sentenced.

The problems that Conn’s is now facing are the same that all perfect shorts face in the weeks and months just before they file for bankruptcy. The credibility of a Perfect Short’s management team steadily declines due to a company’s deteriorating fundamentals and missed earnings forecasts. The result is that the interest by institutional investors to invest in a secondary equity offering wanes. Their market caps also shrink to the point at which that they cannot raise sufficient capital via a secondary offering to pay off their significant amount of debt. Not having access to sufficient equity capital via a secondary offering is an extremely negative situation for a company which is deemed a Perfect Short. It’s because they already have been overwhelmed by debt and have exhausted or have tapped out their lines of credit. They completely run out options to perpetuate their flawed business models.

Conn’s has been on my radar screen as a potential Perfect Short candidate since its shares were trading at above $50 in September 2013. The company had received its second consecutive diagnosis as having “The EPS Syndrome” after it reported its results for its second quarter ended July 31, 2014 in early September 2013. It’s a Financial Statement or Cash Flow Statement disorder that I discovered and named following my performing an autopsy on Enron after it filed for bankruptcy. I had also discovered that there were more than 100 companies prior to Enron including Sunbeam which had un-expectantly filed for bankruptcy after it had been afflicted with The EPS Syndrome. By researching the 100 companies I was able to create an algorithm which automatically detects the syndrome and also the OPS 20 quarter charts which can be used by a novice to monitor and diagnose their holdings in the stock market. .

Below are the StockDiagnostics 20 OPS diagnostics charts for Suprema and Astropower. Both had revenue models that were completely dependent on credit growth. Similar to Conn’s both were profitable, listed on the NASDAQ, owned by institutional investors and recommended by Wall Street analysts prior to their surprise bankruptcy filings. There is also a 20 quarter OPS chart for Conn’s and also for Apple to provide a contrast. The pink shaded areas for Suprema, Astropower and Conn’s indicate the quarters in which the companies were diagnosed as having the EPS syndrome.

Suprema Specialties’s 20 quarter OPS (Operating-cashflow Per Share) chart depicts that the cheese manufacturer and seller generated negative cash flow for all and positive earnings 17 of its last 20 quarters prior to its surprise bankruptcy filing.

AstroPower’s 20 quarter OPS (Operating-cashflow Per Share) chart depicts that the manufacturer and seller of solar energy products generated negative cash flow for all but three of its 17 and positive EPS for 19 of its last 20 quarters prior to its bankruptcy filing.

The trend of Conn’s 20 quarter OPS (Operating-cashflow Per Share) chart depicts that the company went from having majority of green (positive OPS) and grey (EPS losses) for its first 10 quarters to a red (negative OPS) and black (EPS profits) during its last 10 quarters. The change in the trend suggests that the 124 year old company may have made the fateful decision to transition from retailing to higher credit worthy customers and making less profits to low or no credit customers.

Apple is an example of a company which is perfectly healthy. Many of the largest public companies including IBM, Microsoft and Google, etc., have similar 20 quarter OPS chart patterns.

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